RBI links rates to c/a deficit

The Reserve Bank of India’s (RBI) future rate cut decisions will also depend on India’s current account position along with inflation figures.

“We will take into account what the current account deficit is. It will not be driven just by the inflation number or the inflation trajectory,” D Subbarao, governor, RBI, told analysts in a post-monetary policy conference call.

India’s current account deficit widened to a record high of 5.4% of gross domestic product (GDP) in the September quarter as export growth slowed more sharply than imports, with a similar gap expected in the December quarter.

The governor’s comments come a day after the central bank cut its key repo rate for the first time in nine months by 25 basis points, comforted by a drop in headline and core inflation. The RBI also cut banks’ cash reserve ratio, or proportion of deposits lenders must maintain with it in cash, to 4%, from 4.25%, on Tuesday.

Subbarao said current account deficit in 2012-13 would be significantly higher than in 2011-12, and that would have to be factored into monetary policy. For the fiscal year that ended March 2012, the current account deficit was 4.2% of GDP.

However, a record-high current account deficit, a widening fiscal deficit and suppressed inflationary pressures are likely to limit the room for further monetary easing. A high current account gap weakens a currency. For India, which imports about 80 % of its oil, this pushes up domestic fuel prices and adds to inflationary pressure.

Subbarao also said the RBI will keep liquidity in deficit mode as long as it is fighting to control inflation. The central bank’s stated stance is to keep the liquidity surplus or deficit in the banking system within plus/minus 1% of total deposits.